Whatever your reason for becoming a contractor, every payment you receive needs to be treated correctly for tax and any other deductions - based on your jurisdiction of engagement.

Contracting in the UK

Contractors living and working in the UK are liable for UK taxes and National Insurance (NI) contributions on any income, or other gains received or made. The level and type of taxes will depend on whether you are self-employed or employed, and on whether you work through your own personal service company (PSC) or an umbrella company. But in all cases, there will be an income tax liability.

Contracting Overseas

If you work overseas, you may well have to pay local taxes and other levies, as well as UK taxes. The latter applies if:

• you remain a UK tax resident in the UK and,
• if the amount of tax paid locally is less than you have been paid in the UK or,
• if there is no treaty between the UK and the country where you’re working (no double-taxation treaty).

So before you start work abroad, always check what taxes will be due, who will be responsible for collecting the taxes locally and if you are going to remain resident in the UK for tax purposes.

Key Residency factors for contractors to consider:

UK residency status can be a tricky one, so if in doubt, it’s worth taking professional advice. But here is a summary of the qualifying rules:

1. You are likely to spend 183 or more days in the UK in the tax year. This will automatically make you UK resident.
2. Your only home was in the UK and you have owned, rented or lived in it for at least 91 days in total and spent at least 30 days there in the tax year. Again, this confirms UK residency.
3. You have spent fewer than 16 days in the UK in the current tax year, or 46 days if you haven’t been classed as UK resident for the 3 previous tax years. This confirms you are a non-UK resident.

4. You have worked abroad full-time (averaging at least 35 hours a week) and spent fewer than 91 days in the UK, of which no more than 30 days were spent working. Again, this makes you a non-UK resident.

What’s it to be – Umbrella or PSC?

There are broadly two ways in which Contractors can perform services under their contract.

• Umbrella Company

An Umbrella Company contracts with the end client or an agency and the contractor receives payments from them for the work performed. The Company takes responsibility for ensuring the correct tax and other deductions are made, before remitting the balance to the contractor.

There are plenty of providers out there, but it is important to choose one who can be relied upon to make the correct tax deductions and returns to the relevant authorities – especially if you are working overseas.

• PSC (Personal Service Company)

If you operate outside IR35, payments are made to the Company without deductions from the agency or end client. So for every payment made to the contractor by the PSC, the correct amount of personal income tax and NI needs to be set aside and paid to HMRC. This is normally determined when the contractor’s annual Self-Assessment return is completed (Note: all UK resident company directors must complete a Self-Assessment return by 31st January of the following tax year – regardless of their level of income).

IR35 Considerations

IR35 is specific legislation for contractors working through an intermediary, such as a PSC. It is designed to challenge the assertion that contractors are not employees and, in certain

circumstances, treats contractors as employees, where the evidence suggests that in substance (even if not legally) they are no different to employees.

If IR35 does apply, the contractor becomes liable, at source, for PAYE and NI on payments they receive. Presently, for contractors in the private sector, it is the PSC’s responsibility to determine whether a contract is caught by IR35. It is important to get this right, because if challenged by HMRC, the PSC could become liable for past PAYE and NI payments.

Since April 2017, for contractors working in the public sector, it has been the responsibility of the agency supplying the contractor (rather than the PSC) to assess whether or not the contractor falls under IR35 provisions. This requirement is likely to be implemented for all contractors from April 2021.

Claiming Expenses

The rules on claiming of business expenses whilst working on a contract can be complicated. But the general rule is that an expense can be claimed as a deduction against your tax liability, where the expense has been incurred exclusively in the performance of the contract.

Watch out for restrictions where the expense has an element of private use. There are also specific rules around certain expenses, such as mileage, travel and mobile phones. If you are uncertain where you stand on what you can claim, take professional advice.

If you operate through a PSC, expenses can be claimed and paid to them by the PSC – irrespective of whether or not the PSC is reimbursed by the end client.

If you work through an Umbrella Company, you’ll need to agree with them what business expenses can and cannot be reimbursed. Even if you are not reimbursed for business expenses by the Umbrella Company, however, it may still be possible for you to make a deduction for these expenses on the Self-Assessment Return, if it can be shown they were justified to perform the contract.

Income Tax and National Insurance

If you live and work in the UK (and are UK resident for tax purposes) you are required to pay income tax and NI contributions on all net earnings from contracts.

Net earnings are calculated as the total of all earned income, less allowable business

expenses.

Earned income for these purposes includes:

• business expenses which have been reimbursed (either by the PSC or Umbrella Company).
• payments received from the PSC (salary, fees and dividends) or from the Umbrella Company (including any tax and NI deducted at source).

For UK contractors working through their own PSC, income tax and NI (class 2

and class 4) is payable in three instalments:

• the first two being equal amounts on 31 January and 31 July of the relevant tax year which are estimated from your previous year’s tax liability.
• once you complete your Self-Assessment return and have calculated the total amount of tax due, any outstanding balance is payable by 31 January of the following tax year.

UK contractors working through an Umbrella Company will already have made payments under PAYE. But you might also need to complete a Self-Assessment return, if you have:

• earned over £100,000 in the tax year
• received Child Benefit or have other sources of income, or
• wish to claim relief for business expenses (whether or not they have been reimbursed) or other payments

For those working overseas, the requirements for paying tax will vary, so it is important to

use a professional adviser who has experience in dealing with the relevant local authorities, to ensure full compliance with tax regulations and so that you claim double taxation relief in the UK, where permitted.